Episode 3: "Why Does Housing Cost So Much?"

Joseph Smooke, Dyan Ruiz | 02/13/2018

Join Riley and Curtis in a revolving restaurant with an epic view of San Francisco. They're meeting with the banker, Ernesto, who lends money for developments. Discover why it's not all about supply and demand because as he says, "That's not how the industry works."

Notes for Episode 3



    Our friend Sumir told us he only builds condos for people with pretty healthy bank accounts...


    But based on the laws of supply and demand, you'd think that building more units would bring the prices down.


    Well you won't see much building if housing prices go down. You see...





From 2009: https://www.economicshelp.org/blog/1327/economics/why-are-banks-not-lending/



    But increasing supply is the simplest solution to high housing costs. So many people are coming here for all the new jobs!



    Financing isn't that simple. If rents are going down, and a developer comes to me asking for a loan, I'll look at his business plan and tell him "No way." He won't be able to pay me back.


    I'll have the avocado poke toast on charcoal activated bread and a bowl of bone broth.




    Oooh I'll have a matcha green tea donut with bacon!



Wait, so you don't actually want to increase housing supply to the point where prices would fall?


    That's not how the industry works. We have no incentive to invest in declining markets. Remember what happened in 2008? When the housing bubble burst? All the banks stopped lending.


    Prices need to drop approximately 40 percent for Riley and Curtis to be able to afford a place here.


    How do you get housing prices to fall 40 percent?



    That sounds like another Great Recession. But any little dip in prices in San Francisco, means we stop lending here, and invest in another city. Where the housing market is strong.



    You mean a city that's getting MORE expensive?


    Our realtor says a new listing just opened up in the Mission! Let's go!



Additional Notes:

Development budget

A developer has to present their costs for building the project. This includes land, architects, engineers (civil, structural, mechanical, etc.), insurance, fees for permits, lawyers for writing up contracts, loan “closing costs”, building materials, construction labor, etc. At the end of construction, the developer has to convert their construction period financing into “permanent” financing which is where the second analysis comes in.

Cash flow proforma

Assuming the “permanent” loan for the project lasts 20 years or more, the developer has to show that the projects has what’s called “net operating income” aka “profit” for that length of time. Banks assume that expenses will go up every year because the economy depends on inflation. If costs are going up every year, and housing prices start to go down, that means that the developer’s revenue will be going down. If the revenue goes down while expenses are going up, the developer won’t be able to pay the bank. This is a business plan that doesn’t work, so the bank will never make the loan.

Strong vs weak housing market